1776 Energy Partners v. Marathon Oil EF

692 S.W.3d 564

1776 ENERGY PARTNERS, LLC and 1776 Energy Operators, LLC, Appellants/Cross-Appellees

v.MARATHON OIL EF, LLC and Marathon Oil EF II, LLC, Appellees/Cross-Appellants

No. 04-20-00304-CV

Court of Appeals of Texas, San Antonio.

Delivered and Filed: March 29, 2023

From the 218th Judicial District Court, Karnes County, Texas, Trial Court No. 17-02-00033-CVK, Honorable Russell Wilson, Judge Presiding

APPELLANT ATTORNEY: Rodney Lee Drinnon, Marianne Robak, Andrew Green, McCathern PLLC, 2000 West Loop South, Ste. 1850, Houston, TX 77027-3744.

APPELLEE ATTORNEY: Jane Webre, Santosh Aravind, Mark Hanna, Scott Douglass & McConnico LLP, 303 Colorado St., Ste. 2400, Austin, TX 78701.

Sitting: Beth Watkins, Justice, Liza A. Rodriguez, Justice, Lori I. Valenzuela, Justice

OPINION

Opinion by: Beth Watkins, Justice

Appellants/cross-appellees 1776 Energy Partners, LLC and 1776 Energy Operators, LLC (collectively, 1776) challenge a final judgment following a summary judgment and a jury trial. Appellees/cross-appellants Marathon Oil EF, LLC and Marathon Oil EF II, LLC (collectively, Marathon) challenge the portion of the judgment rendering a declaratory judgment in 1776’s favor and awarding attorney’s fees to 1776. We reverse the declaratory judgment in 1776’s favor, render judgment dismissing the claim underlying that declaratory judgment, and remand the cause for further proceedings on 1776’s claim for attorney’s fees. We affirm the remainder of the trial court’s judgment.

Background

Marathon and 1776 are parties to several joint operating agreements (JOAs) under which they share expenses and revenues from wells drilled in areas in which they both hold ownership interests. A JOA is a contract that, inter alia, defines the area to which the contract applies, identifies the parties’ proportionate ownership of the contract area, explains the parties’ rights and obligations, and establishes procedures to be followed if a party defaults on its obligations. Each party’s share of the expenses and revenues is typically determined by its proportionate ownership interest in the well.

Each JOA in this case designates an operator for wells drilled under that contract. The operator conducts the drilling and other operations at the well site, including the sale of any oil or gas produced. The operator recoups those costs by sending joint interest billing invoices (JIBs) to participating non-operator working interest owners. The participating non-operator working interest owners are obligated to pay the JIBs sent by the operator, and the operator is obligated to pay revenues owed to the participating non-operator working interest owners. Either an operator or a non-operator working interest owner may propose new wells in the contract area, and the JOAs establish procedures that control the proposal of and participation in a new well.

Three JOAs between 1776 and Marathon are relevant to this appeal: (1) the Culberson Hughes JOA; (2) the "Longhorn" JOAs, which cover three separate pooled units; and (3) the Bordovsky JOA. The Culberson Hughes and Longhorn JOAs designate Marathon as the operator and 1776 as a non-operator working interest owner. The Bordovsky JOA designates 1776 as the operator and Marathon as a non-operator working interest owner. This means that for wells drilled under the Culberson Hughes and Longhorn JOAs, 1776 is required to reimburse Marathon for 1776’s share of the cost of the wells and, in turn, Marathon is required to pay 1776 the revenue 1776 is entitled to from those wells. In contrast, for wells drilled under the Bordovsky JOA, 1776 is responsible for ensuring Marathon timely receives revenue that it is owed, and Marathon must timely pay its share of costs associated with the wells.

In 2012, a Zavala County trial court imposed a constructive trust on 1776’s assets in a lawsuit that is unconnected to this case. As a result of the constructive trust, 1776 began to suffer cash flow problems. Between April and September of 2014, 1776 failed to pay Marathon more than $2 million in revenue from the Bordovsky wells. 1776 initially held the money in suspense due to a title issue, but by the time that issue was resolved, 1776 had spent the money on other bills. In February of 2015, 1776 stopped paying its share of expenses under the Culberson Hughes JOA because it did not have the money. At that time, there was only one well drilled under the Culberson Hughes JOA, which was called the 301H well. 1776 also stopped paying its share of expenses under the Longhorn JOAs.

For approximately two years, Marathon tried to resolve 1776’s unpaid amounts. However, in August of 2016, Marathon received information that it believed showed 1776 was planning to drill a new well. Marathon questioned how 1776 could fund a new well when it still owed Marathon millions of dollars on wells that already existed. 1776 responded that the new well would be funded by a separate company. Following this dispute, the parties’ relationship deteriorated.

At some point, Marathon began to use a process called "netting" to recoup 1776’s outstanding debts. Netting is using revenue owed to a party to pay down that party’s debts. The parties agree that Marathon was permitted to net within the Culberson Hughes JOA; in other words, it is undisputed that Marathon could properly take revenue it would have otherwise paid to 1776 under the Culberson Hughes 301H well and apply that revenue to JIBs 1776 failed to pay under that same JOA. The parties disagree about whether the JOAs permitted Marathon to "cross-net," or apply revenue owed to 1776 under one JOA to debts 1776 owed under another JOA. Marathon engaged in both netting and cross-netting throughout the time relevant to this appeal.

On October 28, 2016, Marathon sent 1776 and the other working interest owners in the Culberson Hughes JOA authorizations for expenditure (AFEs) proposing three new wells in the Culberson Hughes contract area. Those wells were designated as the 2H, 3H, and 4H wells. As permitted by the JOA, Marathon’s AFEs included a "cash call" indicating the working interest owners would need to pay their proportionate shares of the drilling and completion costs upfront to participate in these wells. When Marathon issued the AFEs, 1776 owned approximately 64% of the working interest in the Culberson Hughes contract area, and Marathon owned approximately 20% of the working interest.

The AFEs indicated that 1776’s share of the drilling and completion costs would be $9.4 million. Under the terms of the JOA, 1776 had thirty days to elect whether to participate in the new wells. If it elected to participate, the JOA required it to pay the cash call within fifteen days of the date of election. If 1776 elected not to participate, or if it elected to participate but failed to timely pay the cash call, the JOA provided for it to be deemed "non-consent" in the wells. If 1776 were deemed non-consent, the JOA allowed the other working interest owners to acquire 1776’s interest in the new wells until the new wells reach "payout."

On November 23, 2016, 1776 elected to participate in the new wells, so the JOA required it to pay the cash call by December 12, 2016. 1776 told Marathon it would "forward the cash call portion of the drilling costs for the three (3) wells as provided for" in the JOA, and it asked Marathon to notify 1776 "when Marathon stimulates the wells, so 1776 can forward it’s [sic] portion of the completion costs for each well."

But 1776 did not have the money to pay the cash call, so throughout mid-December of 2016, it negotiated with outside funders to raise the money. Contemporaneously, it also presented three separate funding proposals to Marathon. In the first funding proposal, 1776 offered to pay the entire $9.4 million cash call for the new wells.¹ As part of this proposal, 1776 asked Marathon to amend the Culberson Hughes JOA and sign a partial release of lien. The amendment and partial release would have provided that Marathon could only apply the cash call funds to the new wells and could not use that money to pay down 1776’s outstanding debts. 1776 identified this amendment as a prerequisite to its outside funders’ agreement to provide cash for the proposal. The parties agree that without this amendment, Marathon could properly take any funds 1776 paid under the Culberson Hughes JOA, including the cash call for the new wells, and apply that money to 1776’s oldest unpaid debts under the Culberson Hughes JOA. Marathon refused to amend the JOA or to sign the partial release of lien, so the first funding proposal fell apart.

On December 12, 2016, Marathon sent 1776 a notice of default stating:

To date, Marathon has not received 1776’s proportionate share of the estimated costs to drill the [new wells]. As a result, 1776 has defaulted on its obligation, pursuant to [the JOA], to fund its proportionate share of the estimated costs to drill the referenced wells. The JOA states that if such default is not cured by appropriate payment on or before five (5) days after this Notice of Default, then the non-defaulting parties may elect to treat such default in the manner as described in the JOA.

The evidence shows that both 1776 and its outside funders were aware that the December 12 letter gave 1776 five days to cure the default by paying the cash call. In response to the notice of default, a 1776 employee emailed Marathon a picture of a man pulling out empty pants pockets.

In the second funding proposal, 1776 offered to pay the $9.4 million cash call for the new wells, plus what it owed in unpaid JIBs on the Culberson Hughes 301H well. In his December 14, 2016 email proposing this arrangement to Marathon, 1776 Energy Operators’s president, Richard Bobigian, estimated that 1776 owed approximately $1 million on the 301H well. A Marathon employee, Keith Wiles, responded to Bobigian’s offer by noting that Marathon’s own records showed 1776 owed $1.8 million on the 301H well.² Wiles asked...